Show me the money: big finance’s contribution to sustainability

The movers and shakers of global finance are never going to win a popularity contest. In 1928, shortly before the Wall Street crash, a director of the Bank of England famously described investment banks as having been “conceived in iniquity and born in sin”.

Modern-day monikers are far more unflattering.

Yet love them or loathe them, it is hard to deny that bankers and other providers of capital have been a powerful force in the advancement of society.

Without financiers, there’d be no train networks, no electricity, no telephones, and no Internet.

To finance experts like Andrew Voysey that’s important to bear in mind as humanity struggles to complete its next grand project: building a green economy.

The logic is simple, says the director of sustainable finance at Cambridge University’s Institute for Sustainability Leadership (CISL). If big finance isn’t on board, an environmentally-friendly economy will never become a reality.

“If we are to build a truly sustainable economy, we need big finance to be part of the effort,” he says. “We will need tens of trillions of dollars of investment to be redirected, which means it is imperative that we build a green financial system at the same time.”

Given the amount of cash required – by some estimates, USD2.5 trillion a year of private investment to be redirected over the next two decades or so – it is odd that banks and investors have been relatively marginalised in efforts to shift the economy to a more sustainable footing. As Voysey observes, although there has been policy action on climate change and environmental matters in the past two decades, “the debate has been dominated by environment and energy ministries within government.”

But that could be about to change. At the G-20 summit in China in November 2016, the world’s leading economies put green finance at the centre of their sustainability plan, the first time such a gathering has done so.

To Voysey, whose research at the CISL informed G-20 finance ministers’ thinking, this was a watershed moment.

“It’s significant that the work the G-20 has just done on greening the financial system was not led by environment ministers. It was overseen by finance ministers and central bank governors. That sends a really powerful signal to everyone. It demonstrates that the issue of green finance is being taken very seriously,” he explains.

So what does turning the financial system green mean in practice? According to the CISL’s blueprint, the required transformation comes in three parts.

Financial innovation

To begin with, banks and other financial players need to come up with more imaginative ways to channel cash to environmental projects. One popular and creative solution that combines the promise of capital returns with protecting the environment is the “green” bond. These interest-paying, tradable securities are essentially loans made by investors to finance the construction of, for example, wind and solar farms and sustainable manufacturing plants. They’re particularly popular among large institutional investors such as pension funds, who are under greater pressure to invest responsibly. The market has seen explosive growth, with some USD130 billion of such bonds expected to be sold this year, up from USD23 billion in 2013.

“These are very positive signs,” Voysey explains. “It shows that if the structures can be found to allow investors to put their capital to good use, the investment flows very quickly.”

Many countries use green bonds to fund a range of energy efficiency initiatives. China is by far the largest issuer and expects to sell up to USD460 billion in green bonds to invest in technology that could significantly reduce business and household energy consumption over the next decade.

In Mexico, meanwhile, government agencies use green bonds and loans to pay for the installation of energy-efficient public lighting and the replacement of inefficient household appliances. Australia has a similar programme in place, using new capital for energy efficiency in local government, health and agriculture.

"If big finance isn’t on board, a sustainable economy will never become a reality"

Acknowledging the environmental cost of business activity

Another essential element of sustainable finance, the CISL says, is for corporations – financial and non-financial – to develop a clearer understanding of the ecological impact of economic activity. Currently, the world economy is wedded to a “take, make and dispose” operating model that’s founded on an excessively narrow view of the cost of doing business.

This means that the prices investors pay for securities – whether they’re company stocks or bonds – fail to account for firms’ wider interactions with the environment. A truly sustainable system, Voysey says, would quantify these inter-dependencies, both positive and negative, and ensure they are embedded in the valuations of investment securities.

"When it comes to efforts to capture the true costs of business, many flowers appear to be blooming at the same time"

Encouragingly, there are signs that banks, investors and regulators are moving in this direction.

In some countries, banks now require business customers to meet certain environmental standards as a condition for doing business. Chinese commercial bank ICBC, for example, audits potential clients to gauge whether they are at risk of breaching the country’s air quality regulations. French banks are beginning to carry out similar climate-related stress tests. Separately, more than 30 of the world’s stock exchanges are working to make the environmental records of companies they list visible to investors.

“When it comes to efforts to capture the true costs of business, many flowers appear to be blooming at the same time,” Voysey says.

Embedding a long term perspective

But these efforts will count for nothing if banks, investment companies and their peers don’t get better at taking a long term view. Financiers gave birth to the culture of corporate short-termism in the 1980s, so they are uniquely placed to eradicate it.

For its part, CISL is advocating policies that promote better stewardship and long term decision-making right across the investment chain. Voysey and his team argue that if shareholders adopt practices that reward company executives for long-term performance – both financial and environmental – then the finance system can become more of a guardian of our planet. Some of the world’s largest institutional, and most influential, investors are starting to take this on board. The Netherlands’ PFZW pension fund and Norway’s sovereign wealth fund are among those eradicating investments in fossil fuels and forcing companies in that industry to divert investment to clean energy products. More broadly, a group of asset owners and managers that works with CISL – the Investment Leaders Group – has published what it believes are the essential ingredients of “long-term, sustainable investment mandates”. And crucially, surveys show that more than 90 per cent of investment management companies are integrating environmental, social and governance (ESG) considerations into their decision making because they believe it will improve investment returns.

"Greening the financial system has started to become mainstream thinking, and is seen as essential part of achieving economic growth within the limits imposed on us by the ecological system"

It is still early days of course. And efforts to shift the financial system to a more sustainable model are inevitably complicated by the fact that banks in many parts of the world are still feeling the effects of the 2008 crisis. Yet, with regulators and large investors beginning to take sustainability seriously, Voysey is confident his vision might soon become reality. “Greening the financial system has started to become mainstream thinking, and is seen as essential part of achieving economic growth within the limits imposed on us by the ecological system.”